CAN SLIM II: The Gold At The End Of The Rainbow

Don't dabble in stocks. Dig in and do some detective work.
— William J. O'Neil in How To Make Money In Stocks

Sometimes it pays to go to an expert for advice. In this case, however, the expert came to me. Avinash Agrawal is a stock researcher for SierraInvestor.com with a master's degree from Stanford University, where he majored in finance with an emphasis on pricing stocks and derivatives. Having read my first Working Money article on CAN SLIM, Avinash suggested I try a slightly different approach.

Previously, I had listed the main characteristics of CAN SLIM as they fall into the method's name:

Current quarterly earnings per share: should be accelerating.
Annual earnings increases: a meaningful growth.
New products, new management, new highs: buy at the right time.
Shares of common stock outstanding: keep it small.
Leader or laggard: Find an industry's leaders, not laggards.
Institutional sponsorship: a little goes a long way.
Market direction.

When asked if he could rank the CAN SLIM criteria from most to least important, Agrawal's answer was to start with the "M" — market direction.

START WITH THE MARKET
As he put it: "First and foremost, look to the market for direction. The market's direction dictates the importance of the rest of the CAN SLIM criteria. For the past few years the market has been flat, trading within a range, and therefore, profits are found by sector trading." Then, once market direction has been established, look for the top-performing sectors. Agrawal suggested using the top 20 from the past two to three months. Then, with those sectors in mind, start looking for those individual stocks making new 52-week highs. From there, check the fundamentals; good fundamentals keep the stock from going down. But technicals get the edge over fundamentals — a stock with great fundamentals won't necessarily go up, but if the technicals are good, the stock will rise. Price is based on the law of supply and demand.

According to Agrawal, those quality stocks making new highs in price should also be added to your watchlist, "as they may offer buy points while making their first pullback to the 50-day moving average or otherwise consolidating to break out again. Such consolidations last typically seven weeks. So the lower portions of your watch list will have stocks in the consolidation phase, while the top portions are those you are currently watching."

CAN SLIM watchlists should be updated regularly, with stocks close to breakout placed near the top of the list. If they don't break out, say within two weeks, or if the breakout fails, move them to the lower portion of your watchlist or remove them altogether. In general, CAN SLIM stocks have the potential to make huge moves of "100% to 300% or more," as Agrawal noted. But when markets themselves are in a trading range and profits are hard to come by, he continued, it's a good idea to take profits around 20% to 25% above your buy point.

Keeping all that in mind, the reordered list now reads:

Market direction: trading range

Leaders & laggards in sectors and
New highs

Institutional sponsorship and
Shares outstanding — the fundamamentals

Current quarterly earnings and
Annual earnings

CAN SLIM IN ACTION
Following Agrawal's advice, I began my search at CBS MarketWatch's website, where I looked for the top 10 sectors for the past two months (Figure 1).

Figure 1: Top-performing sectors from CBS MarketWatch/BigCharts/Industries/Best Performers.

With those sectors in mind, I went to the new 52-week high list (Figure 2). This is where Agrawal said to begin looking for individual stocks. I started with NASDAQ; the Dow Jones Industrial Average (DJIA) list made up of blue-chip companies was less appealing. It would be less likely that one of their stocks would experience any explosive upward growth. And AMEX has smaller, perhaps less stable stocks. NASDAQ it was.

Figure 2: Daily listing of NASDAQ new highs. BigCharts lists the new highs for the day in their "Big Movers: NASDAQ New Highs" list.

The first stock on the list, Joy Global, Inc., was in the commercial vehicles and trucks industry, not my top 10 list. I decided to move onto the next stock.

Gulf Island Fabrications (GIFI) was in the oil and equipment services, a hit on my list, so I looked up their fundamentals. They had 12.2 million shares outstanding, with a market cap of $329 million. That's a small cap — very good. And institutional sponsorship (information I finally found in Yahoo! Finance/Quotes & Info/Key Statistics by clicking on the "More Statistics" button) at 63.9% was a little high, but acceptable (Figure 3).

Figure 3: Institutional interest in GIFI is at 63.9%.

William O'Neil, the founder of the CAN SLIM approach, has a rule of thumb: To buy a stock with a little institutional sponsorship, but not too much. This is one of the more subjective CAN SLIM rules; in addition to the amount, the quality of the sponsorship is important. If you can find out who the sponsors are — institutional sponsors are large buyers such as mutual funds, pension funds, banks, and large money investment firms — then you should be able to tell whether they're "intelligent" buyers. You only want a few, preferably intelligent buyers, because dramatic rises in a stock's price are caused by large institutional buyers, not individual buyers.

At this point, I decided to check the sector for leaders and laggards. Of GIFI, 86% was owned by institutions or insiders. That sounded a mite bought-out to me. And without looking up the earnings, the five-year chart didn't show a lot of growth. In fact, it looked flat, like the market (Figure 4).

Figure 4: From a five-year vantage point, you can see how big the breakout and new high were. GIFI had been bouncing off of resistance at $25 for years.

After a little more research, the leader in the oil equipment and services sector's quarterly earnings turned out to be a company called Natural Gas Services Group (NGS) with a 218% increase in profits. GIFI didn't even make the list. Before looking at anything else, I pulled up a chart of NGS (Figure 5).

Figure 5: Six-month chart of NGS. Look at the volume on that thing!

Was I excited? Yes! This was exactly what I was looking for — maybe two days late, but I can buy in on the next pullback. Filling in the rest of the blanks, NGS has 7.1 million shares outstanding, a market cap of $154.32 million, 10.6% institutional sponsorship, and increasing quarterly and yearly profits. Amazingly, Yahoo! lists the institutional owners and when they bought the stock (Figure 6).

Figure 6: Low and recent institutional interest in NGS; 10.5 of the 10.6% institutional sponsorship bought into this stock within the last quarter.

How perfect is that? Now all I have to do is wait for the right entry point.

MONEY MANAGEMENT
Finally, a few sage words of advice from Avinash Agrawal on handling a stock... once you've got it:

The 7­8% stop-loss is always employed. I take some profits at 20% gain (by selling say half the position) and holding the remainder for a move of say 100% or even more. O'Neil says that if a stock makes a 20% or so gain in eight weeks, it has the potential to make a huge move. Also after taking the 20% profit, if the stock pulls back either near breakout or the 50-day moving average, it can be bought again.

MAKING THE CHANGE
Is this a huge amount of effort? Perhaps. But it's worth it to know that you're making sound decisions in your investing, and this method shows you where to find good stocks, how to evaluate them, and how to trade them. Not bad for a few letters of the alphabet. And all this information can be had for free by anyone with Internet access, perseverance, and... well, maybe a little capital.

Sharon Yamanaka may be reached at SYamanaka@Traders.com.

SUGGESTED READING
O'Neil, William J. [1988]. How To Make Money In Stocks, McGraw-Hill.
Yamanaka, Sharon [2005]. "Get the 'CAN' In CANSLIM," Working-Money.com, August 8.

·www.canslim.net

Current and past articles from Working Money, The Investors' Magazine, can be found at Working-Money.com.